highlighted the issue of accepting and using virtual currencies for differentpurposes,

including, buying commodities or services,saving, as

well asconverting into realcurrencies,

such as USdollars,

euro or other currencies.

One of the mostcontroversial

and the most advancedvirtualcurrency scheme

to

date

is the oneso-calledBitcoin, designed andimplemented by the Japanese programmer Satoshi Nakamoto in 2009.Although

the use of Bitcoin might havepositiveimpact on

financialinnovation and the provision of additional payment alternatives toconsumers,it also might increase the risks in financial payments, exchangerates of real currencies, as well as increase the possibility of moneylaundering, using them for illegal deeds.

Therefore , the purpose of this paper to clarify the main characteristicof Bitcoin, and analyze its positive aspects as well as the threats thatmayoccur to the modern world economy , in case the usage of this money ,significantly increases .

Keywords:

virtual currency ,e-money,financialand pricestability, risks

Introduction

Money is a social institution:

a

tool created and marked bysociety’sevolution, which has exhibited

a great capacity to evolve and adapt to thecharacter of the times

.Economists differentiate among three different typesof money:commodity money, fiat money, and

bank money.

Whilecommodity money

(such as gold coins) is no longer performing itsoriginate function , so called“fiatmoney”2

,as well asbank money

(checks issued by banks) have took its place and are widely used in allmodern economies.

Being issued by the central banks,people have

accepted fiatmoney in

exchange for goods andservices,

simply because they trust this central

authority

whichiscrucial

element of any fiat money system.

1

Author is assistant professor at the University “Goce Delcev”-Faculty of Economics-Stip,

e-mail:violeta.madzova@ugd.edu.mk

2

Fiat money is a good, the value of which is less than the value it represents as money.Dollar bills and

banknotes

are examples

of fiat money

2

Additional reason for wide acceptance of fiat money is of course,possibilityto unite three different money functions intoone,

i.e.moneycan

be:

-used

as a

meanof exchange

-intermediary in trade to avoid barter system,

-used as

a standard numerical unit for the measurement of value .

-saved andused as a store of value for the future times.

Dueto the recent technological developments and especially highpenetration of the

internet, there has also been adevelopmentof

virtualcommunities in recent years. A virtual

community3

is to be understood as aplace within

cyberspace where individuals interact and follow mutualinterests or goals.

In some cases, these virtual communities have createdand circulated their own digital currency for

exchanging the goods andservices they offer, thereby creating a new form of digital money

However, it is clear that they can also pose risks for their users,especially in view of the current

lack of regulation.Infact, virtual currenciesact as a medium of exchange and as a unit of account within a

particularvirtual community. The question then arises as to whether they also fulfil the“store of

value” function in terms of being reliable and safe, or whether theypose a risknot only for their

users but also the wider economy.

Virtual currency schemesin the new e-communities

A virtual

currency can be defined as a type of unregulated, digital money,which is issued and usually

controlled by its developers, and used andaccepted among the members of a specific virtual

community.

The virtual currency schemes are still new and there is still vagueunderstanding of their nature, thus mix them withso called “electronicmoney”. Namely, as it is stated inthe Electronic Money Directive(2009/110/EC), “electronic money” is monetary

value as represented by aclaim on the issuer which is: stored electronically; issued on receipt of

fundsof an amount not less in value than the monetary value issued; andaccepted as a means of

payment by

undertakings other than the issuer.

Although some of these criteria are also met by virtual currencies,aclear

distinction should be made between

virtual currency schemes andelectronic money. i.e:



In electronic money schemes the link between the electronic moneyand the traditional money

format is preserved and has a legal foundation, asthe stored funds are expressed in the same unit

of account (e.g. US dollars,euro, etc.).



In virtual currency schemes the unit of account is changed

into avirtual one.

3

There are

many examples of virtual economies, in terms of social networks(

Facebook,MySpace, Twitter), knowledge

virtual community

(Wikipedia),

or

those

that create a virtualworld (Second Life) or create an online environment for

gambling (Online Vegas Casino).

3



Electronic money schemes are regulated and electronic moneyinstitutions that

issue means of payment in the form of electronic money aresubject to prudential supervisory

requirements. This is not the case forvirtual currency schemes.



Electronicmoney is primarily

subject to the operational riskassociated with potential disruptions to the system on which the

electronicmoney is stored.



Virtual currencies are not only affected by credit, liquidity and

operational risk without any kind of underlying legal framework, theseschemes are also subject to

legal uncertainty and fraud risk, as a result oftheir lack of regulation and public oversight.

It is important to underline that, there three types ofvirtual currencyschemes

which depens

on their interaction with traditional, “real” money andthe real economy:4

-

Type 1, which is used to refer to closed

virtual currency schemes, basicallyused in an online game;

-

Type 2

virtual currency schemes have

a unidirectional flow (usually aninflow), i.e.

there is a conversion rate for purchasing the virtual

currency,which can subsequently be used to buy virtual goods and services, butexceptionally

also to buy real goods and services;

-Type 3

virtual currency schemes have bidirectional flows,

i.e. thevirtualcurrency in this respect acts like any other convertible currency, with twoexchange

rates (buy and sell), which can subsequently be used to buyvirtual goods and services, but also to

purchase real goods andservices.

One of the most typical and developed “type 3” virtual currency issocalled Bitcoin.In factBitcoin shares characteristics of both commoditymoney and fiat money, but does not fit properly in either category. Bitcoinsupersedes commodity money in value density, recognizability anddivisibility. It also resembles commodity money in that, at least during theexpansion of the Bitcoin base, its value, assuming competing suppliers, isequal to its marginal cost of production. However, unlike commodity money,bitcoins, which exist only as

numbers in a computer, have zero value as acommodity in the real world. On the other hand, fiat money commands avalue far higher than its costs of production, which raises the risk ofmismanagement by their monopolistic suppliers.

The nature of a

Bitcoinas a virtual currency scheme

Bitcoin

is decentralized virtual currency , which is traded on line and isexchanged into US dollars or other currencies. Bitcoin ,allows

users to minebuy, sell or accept bitcoins from anywhere in the world. However , no matterhow muchworldwide

bitcoin community is spread over , it doesn’t havecentralized data base or authority, but a peer to peernetwork. It enables

4

See more :BRODBECK, Simon “Virtual money–

A new form of privately issued money inthe money

market”, European School of Management, Paris, May 2007.

4

creation of bitcoins through mining process and validates the transactions.According to the latest information there are over 8,8million

coins incirculation5. Estimating the bitcoin price at the level of 4-5USdollar/per 1Bitcoin , the Bitcoin community value is estimated between 35-44million

US dollars.

According

to Bitcoin, the scheme has been technically

designed insuch a way that the money supply

will develop at a predictable pace. Thenumber of Bitcoins generated per block isset to decrease geometrically, witha 50% reduction every four years. The result is that the number

of Bitcoinsin existence will reach 21 million in around 2040.(see: Table 1)

Table 1:

Trend of bitcoin over time

Source :http://www.ecb.int/pub/pdf/other

Bitcoins are not pegged to any real-world currency. The exchange rate isdetermined by supply and

demand in the market.

There are several exchange platforms for buyingBitcoins thatoperate in real

time, such as

Mt.Gox

whichis the most widely usedcurrency exchange platform and allows users to trade US

dollars forBitcoins and vice versa.

In order to start using Bitcoins, users need to download the free andopen-source software. Purchased

Bitcoins are thereafter stored in a digitalwallet on the user’s computer. Consequently, users face

the risk of losingtheir money if they don’t implement adequate antivirus and back-upmeasures.

5

European Central Bank,“Virtual currency schemes “October 2012,

pg 18http://www.ecb.europa.eu/home/html/index.en.htm

5

However, it is also true that the system demonstrates a clear case ofinformation asymmetry. It is

complex and therefore not easy for all potentialusers to understand. At the same time,

users can easily download theapplication and start using it even if they do not actually know how

thesystem works and which risks they are actually taking. This fact, in a contextwhere there is clear

legal uncertainty and lack of close oversight, leads to ahigh-risk situation.

The turbulent path of a Bitcoin

Bitcoin, the infamous pseudonymouscryptocurrency with no centralizedauthority, has had a tumultuous history so far.In 2008, Satoshi Nakamotoself-published a paper outlining his work on The Cryptography Mailing list atmetzdowd.com and then on 3 January 2009 released the open sourceproject called Bitcoin and created the first block, called the “Genesis Block”6.Through 2009 and early 2010, bitcoins had no value at all, and for the firstsix months after they started trading in April 2010, the value of one bitcoinstayed below 14 cents. Then, as the currency gained viral traction insummer 2010, rising demand for a limited supply caused the price on onlineexchanges to start moving so by November 2010 , it surged to 36 cents ,while in February 2011, it rose again and it hitUSD 1,06 before settling in atroughly 87 cents.

From early April 2011 to the end of May 2011, the goingrate for a bitcoin rose from 86 cents to

USD8,89. The highest pic wasreached at the beginning of June when the market value of all bitcoins incirculation has tripled and was approachingUSD 130

million.Then ,cyberattack perpetrated on

20 June 2011, managed to

decrease

the valueof the currency down from USD 17,50 to

USD 0,01 withinseveralminutes.According to currency exchange Mt.Gox

platform, one accountwith a lot ofBitcoins was

compromised andthe stolen lot was first

soldout and thenboughtback again, with the intention of withdrawing the

coins. The USD1,000/day withdrawal limit was active for this account and the hacker wasonly able

to exchange USD1.000

worth of Bitcoins. Apart from this, no otheraccounts were compromised,

and nothing was lost.

The pricedramaticallydropped down, butit

quickly drove it back up, limiting the thief’s haul to onlyaround 2.000 bitcoins. The exchange ceased operations for a week androlled back the

post-crash

transactions, but the damage had been done asthe bitcoin never got back above $17.7

( see Table 2)

Table 2:Bitcoin exchange rateover time

6

Benjamin Wallace, “The rise and fall of a BITCOIN”; November 23,2011, pg2

6

source:

htpp://bitcoincharts.com /charts

Monetary aspects ofthe

Bitcoin virtual currency scheme

As the Bitcoin scheme is designed as a decentralized system where nocentral monetary

authority is involved,

the supply of money does not dependon the monetary policy of any virtual central bank, but rather evolves basedon interested users performing a specific activity.

Therefore, users have several incentives to use Bitcoins.

1. Transactions

are anonymous,as accounts are

not registered and Bitcoinsare sent directly from one computer to another.

outside these communities can be expected to materialise inthe current situation.

More precisely the following typesofrisksmight

occurby using theBitcoin currencyscheme8:

-Credit risk-Users are exposed to credit risk in relation to any funds

held on the virtual accounts,

as it cannot be guaranteed that the settlementinstitution is able to fully meet its financial

obligations when these are due orat any time in the future.

-Liquidity risk-Users are also exposed to liquidity risks if the settlementinstitution fails to meet

any commitments it has made to provide liquidity tothe participants as and when expected.In this regard, virtual currencyschemes are veryilliquid as a result of the low volumes traded.In the eventof security incidents, the conversion of users’ funds into real money wouldprobably

caused, in part, by central banks not doing their jobs properly. As aconsequence,

this risk should be considered when assessing the overall risk

situation of central banks.

If the Bitcoin might be consideras threat

to price, financial and thepayment stability

of the modern economies?

Bitcoin as virtual currency scheme may be inherently unstable.But, due toits

limited connection to the real economy,

the low volumes traded and thelack of wide useracceptance for

the time being, it seems that it

still

doesn’tjeopardise

financial stability

of the economies which citizens use Bitcoin

asa means of exchange or payment.

The limited volume of a Bitcoin in circulation alsodoesn’tpose

a riskfor price stability at this stage, provided that the issuance of moneycontinues

to be as stable as it seems to be at present. In the short tomedium term, no significant impact can

be expected on the velocity ofmoney. However, it is probably worth monitoring the interaction

betweenvirtual currencies and the real world.

Bitcoinschemesdo

not allow borrowing or lending. But this maychange

in thefuture. There is even speculation on how Bitcoin could evolve.Banks could, for instance, act

as

a depository for the wallet files that containusers’ Bitcoins.

The banks could then pay interest to those who hold the

virtual currency with them. Alternatively the Bitcoin system could even startworking as a fractional

reserve

system, extending credit over and above itsactual reserves. However, the scheme’s

supporters are clearly opposed tothis. These developments, if they came to pass, could indeed have

a

certainimpact on financial stability in the future.

In the particular case of Bitcoin, which is a decentralised

peer-to-peer virtual currency scheme, there is not even a central point of access, i.e.there is no

server that could be shut down if theauthorities deemed itnecessary.

As a consequence, governments and central banks would faceserious difficulties if they

tried to control or ban any virtual currency scheme,and it is not even clear to what extent they are

permitted to obtaininformation from them.

Therefore,

the

main activitiesto prevent negative impact of the Bitcoinschemes might be seen in constant monitoring of the Bitcoin developmentand well as in creating aproperlegal

basis for virtual currency schemes

ingeneral.

The legal basis

of a payment system consists of frameworklegislation, as well as specific laws, regulations, and

agreements governingboth payments and the operation of the system.Bitcoin need tohaveproper

legal framework, as well as a clear definition of rights and obligations for the

different parties. Furthermore, the global scope that most of these virtualcommunities enjoy not only hinders the

identification of the jurisdiction underwhich the system’s

rules and procedures should eventually

be interpreted.

9

Conclusions

In the traditional markets,

central governments manage the currencies andtheir performance based on a number of factors often questionable.However the introduction of the virtual currency schemes ,especially

thewider use of the most popular and the same time the most controversialvirtual currencyscheme called Bitcoinischaracterized

with the

absence ofcentral government whom decisions

could induce phenomena of inflation ordeflation and the anonymity of the transfer between entities in the network.

In an extreme case,this virtualcurrencycould

have a substitution effect oncentral bank money if they become widely accepted.

The increase in the use of virtual money might lead to a decrease inthe use of “real” money, thereby also reducing the cash needed to conductthe transactions generated by nominal income. In this regard, a widespreadsubstitution of central bank money by privately